Surging Aussie Dollar Keeps Door Open To Rate Cut

The Australian dollar is surging again, increasing chances the central bank will cut interest rates further.

The Aussie rose to its highest level in four months this week. On Friday, it was trading in Asia around 0.9630 to the U.S. dollar, up from $0.8900 at the start of September.

The currency is up in part because of the growing view that the U.S. Federal Reserve won’t start scaling back its extraordinary monetary stimulus until next year, following the economic disruption caused by this month’s government shutdown.

A pullback in easy money policies would push U.S. yields up, and the U.S. dollar higher. A delay in this – added to concerns over the U.S. government shutdown – has nudged the Australian currency up 5% from lows two months ago.

That’s causing a policy conundrum for the Reserve Bank of Australia.

A strong currency hurts Australia’s manufacturers by making their goods more expensive overseas. That’s bad news for the government, which is hoping this sector will help pick up some slack in the economy.

Australia’s economy grew by 2.6% on year in the second quarter, compared with growth as high as 4% in early 2012, as mining profits fell in line with China’s slower growth.

A rate cut would lead the currency lower, helping exporters. But it also risks stirring up even more frothiness in the country’s housing sector, which already is showing signs of overheating after eight rate cuts over the past two years.

For now, RBA Governor Glenn Stevens seems to be trying to talk the currency lower.

“I don’t think you could say that the level of costs and productivity in Australia…would point you to present or higher levels as being really sustainable,” he said in a speech Friday.

The world’s biggest bond investor, Pacific Investment Management Co., said in a recent report that more rate cuts were likely in the offing given the fragile state of the economy.

“In this environment, we expect that the RBA will have to keep interest rates low for an extended period, and likely lower them further, supporting bond prices over the cyclical horizon,” PIMCO said.

Ben Jarman, an economist at J.P. Morgan & Chase, said, “The current mix of currency and interest rate settings are too tight for the real economy, and cannot persist.”

Bill Evans, global head of economics at Westpac, an Australian bank, said Friday investors are likely to begin factoring in more rate cuts.

The central bank’s next board meeting is Nov. 5. Until then, expect Gov. Stevens to keep trying to talk the currency lower.